Description

Investment Summary

Cannabis Strategies Acquisition Corp. (CSA/A CN, “CSAC”, or the “Company”) is one of the most uniquely undervalued companies we have seen in some time.  CSAC is a SPAC (“Special Purpose Acquisition Vehicle”) whose management individually handpicked a portfolio of five cannabis companies (the “Anchor Companies”) that were specifically chosen to create a fully vertically integrated platform that would manage the entire farm-to-retail process.

 We will go into more detail about the business, why the opportunity exists and how the industry is evolving below, but think its most prudent to begin with enormity of the valuation gap between CSAC and its peers to put special emphasis on the current investment opportunity. The current valuation anomaly has been caused by a confluence of technical factors that will abate over the coming weeks, so we begin by describing the current opportunity as we don’t believe it will exist once the transactions close and sell-side analysts begin to pick up coverage of the company.

Below are CSAC’s publicly traded peers:

As seen above, CSAC’s average peer trades at a ~20x EBITDA multiple and 5.7x Sales multiple while operating at a 32%-35% EBITDA margin.  CSAC, on the other hand, currently trades at less than 4x EBITDA and 2x sales while operating at the same EBITDA margin.  To put this into perspective, if CSAC traded at merely the average valuation of their peer group, the stock would trade at $49.75.  The stock currently trades at $16.70.

But perhaps there is something abnormal about 2019, so let’s look at 2020 as well. The same peer group trades at 3.4x sales and 10.2x ebitda on 2020 consensus metrics while growing revenue 82% and operating at a 34% EBITDA margin.  Meanwhile, CSAC has guided to over 100% revenue growth and a ~50% EBITDA margin in 2020, making them the best performing company in the group.

Margin of Safety

We believe the company is well positioned with top-notch management as we describe in more detail below, but both as a sanity check and to further demonstrate the depth of the valuation differential between CSAC and its peers, we also illustrate the Company’s valuation even if one assumed the Company traded at a 25% discount to the peer group average.  This would imply a price of $37.16, yielding a 100% return on your investment.

Technical Factors

The obvious question is why this market inefficiency exists, and what the catalyst is to realize the Company’s value.  On the first question, the combination of CSAC’s current market cap of <$500mm; lack of sell side coverage; it’s Canadian domicile and the fact it is temporarily a SPAC has caused this valuation anomaly. A SPAC is a vehicle that is capitalized with the task of purchasing an undervalued company or companies.  In this case, the SPAC purchased a portfolio of five vertically integrated cannabis companies. But SPACs have certain restrictions: for example SPACs cannot trade on certain exchanges; certain investors cannot invest in SPACs, etc. However, once the transactions close in January, the SPAC status falls away and CSAC trades as any standard public company would.  This is one of the reasons the current valuation gap exists, and also a catalyst for the valuation gap to collapse.  Further, upon the closing of the transaction, we expect the company to obtain sell-side coverage and begin trading at peer valuations. 

Additionally, as we speak to management teams and analysts it appears there is increasing interest in the space due to the recent investments and joint ventures with the larger and more established players in related industries.  For example, STZ, a ~$50b alcohol company owning more than 100 brands, recently made a $4b investment into another cannabis company, leading STZ investors to begin examining the opportunity for growth for STZ through this investment. Similarly, Coke has announced discussions with another cannabis company about creating marijuana infused drinks (https://www.cnbc.com/2018/09/17/coke-aurora-cannabis-in-talks-to-make-marijuana-infused-drinks-bnn-bloomberg.html.)  As investors realize management of multi-billion dollar companies view the industry attractively, we believe interest will pick up significantly and a new set of investors will begin to invest in the industry.  Further, as companies like STZ begin taking significant stakes, M&A should begin to embed itself into the industry multiple.    

Industry

The industry is compelling as it is going through positive regulatory changes causing incredible amounts of growth.  In October, Canada officially legalized marijuana opening up a new market. In the United States, 33 states have a form of legalized marijuana: ten of those for recreational purposes and 23 for medicinal purposes.  It’s largely expected NJ, Illinois and other states will follow suit shortly. 

Further, with Democrats taking control of the House, and an ardent opponent of cannabis legalization Jeff Sessions no longer Attorney General, most view the regulatory environment as becoming more supportive over time.  The most recent Pew Poll had >60% of Americans supporting the legalization of marijuana.

With regulation easing, a natural question is how big the market is.  Estimates vary greatly, but just to give just a rough sense of the size of the market, Cowen estimates that the U.S. Market will be $75b of revenue by 2030. Note that this excludes the revenue opportunity from every other country of the world. It also excludes marijuana-related revenue, such as clothes or paraphernalia.  Naturally, CSAC’s vertically integrated position in multiple states (on both the West and East Coast) sets it up well for expansion and growth.

The Company

CSAC is run by what we believe is of the top management teams in the space, including the former Chief Marketing Officer of AB-Inbev, who also held top management roles at Coke and P&G.  This management team individually handpicked a portfolio of five cannabis companies (the “Anchor Companies”) that were specifically chosen to create a fully vertically integrated platform that would manage the process from farming of the plant through selling it at retail.   All five companies were subject to 3 year audits through 9/30/18, and already has in-place revenue and ebitda larger than many of its comps.

Our diligence also leads us to believe that the company, by creating a vertically integrated portfolio, has created a number of ancillary benefits that will lead to even more outsized growth.  In addition to vertical integration allowing the company to institute quality control from start to finish, companies that are vertically integrated receive additional benefits ranging from extra tax benefits (i.e. extra deductions) to always having consistent sources of demand from their own dispensaries while lowering the risk of supply disruptions. 

CSAC has also begun developing IP around their proprietary brands (such as KYND and Cannapunch) as owning retail gives them a natural advantage to push their own product.  Management has also discussed that their retail stores allow them to learn customer preferences and adjust both production and supply accordingly. Finally, while the companies first acquisitions focused on more mature markets, making acquisitions and running them through their vertically integrally platform makes acquisitions a consistent supply of growth as they seamlessly add capacity running new business through their platform. 

Conclusion

Given a series of technical dynamics causing a massive valuation distortion to its comp set, coupled with a large marge of safety, regulatory tailwinds and a top management team, CSAC represents one of the best risk-rewards we have seen in some time.  As we demonstrated, an investor could cut the multiple by 25% and still double their return.  Further, with the transaction expected to close in January, the catalyst is short-dated.  Finally, with the world’s largest companies like Coca-Cola validating the industry and looking to produce ancillary products such as cannabis infused drinks, the companies pick up a double benefit of extra growth while piquing the interest of a large and increased investor base. 

Catalyst

January transaction close